How to value IFA Businesses
There are different methods used to value IFA businesses. The different types are detailed below:
Multiple of recurring income streams.
Typical valuation of ‘3 x trail’ (i.e. buying some of the assets from a company but not the legal entity itself). Generally this will be payable in 3 stage payments: example 1 – 50% up front plus 25% in 12 months and 25% in 24 months; example 2 1/3rd, 1/3rd and 1/3rd; example 3 50% upfront and remaining 50% payable in equal monthly payments from month 7 to 18. This valuation model is often used for transactions with an Enterprise Value (EV) generally lower than £1.5m / £2m. Occasionally, we will achieve multiples above 3 times e.g. 3.5 to 4 times where there is a longer deferment period or to recognise additional goodwill where there are exceptional new business volumes.
Multiple of Funds under Management
Typical valuation of 2% of Funds under Management with 50% payable up front and second 50% payable in 2 or 3 years. IFAs should generally ignore multiples of FuM as a valuation metric, as this is far more relevant to Wealth Managers (running discretionary portfolios on a single custodian’s platform). This method is also often used where the business is being acquired and the principal will stay for a period of time during the transition stage on an employed basis.
Initial Consideration / Deferred Consideration
The reason behind purchasers setting out their terms split between Initial Consideration (IC) and Deferred Consideration (DC) is largely because of uncertainty whether clients will be retained. Another factor will be when some of the recurring fee income is via legacy trail and whether this income will be switched off post Sunset clause in April 2016. As a result very few deals include a totally fixed consideration. You might be quoted 3 x trail with 1/3 IC and 2/3 DC paid in tranches at the end of the first and second years, but the IC is the only element of the transaction that is fixed and therefore guaranteed. The DC is based on future performance (value of recurring income at future dates). Businesses selling their client bank will normally be expected to continue to hold run-off PI cover until at least the company is wound-up and deauthorised from the FCA.
EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation).
Buying the legal entity focuses on the business as a whole and uses a suitable valuation metric as a result (EBITDA). This is a non-GAAP (generally accepted accounting principle) calculation.
The EBITDA valuation model is probably the best measure of your firm’s real value. It is most closely related to operating profit. With this type of valuation model we consider the factors that impact a valuation.
Once the EBITDA figure is agreed between the seller and purchaser a multiple is applied to reflect attractiveness, regular interaction with clients, whether agreed client fee agreements are in place, market sentiment and so on.
Multiples can be as high as 4 – 8 times EBITDA for a firm that is achieving scale with strong future prospects. An initial and deferred consideration would normally be part of the buy-out contract terms.
Assured Annuity Plan (AAP)
This model allows the IFA to benefit from any increase in recurring income post completion. An example of using an Assured Annuity Plan or otherwise known as a Retirement Plan is likely to provide an equivalent return of up to 6 times recurring income. Following a minimum 12-month integration / handover period an upfront payment of 40% of gross recurring income is paid, followed by a 15-year pay-out period of 30% of banked recurring income, (benefitting from any stock market growth); plus 20% of all new initial business conducted over the next 15 years and 30% of any ongoing recurring income on these new monies. The AAP can be paid personally or via your nominated trustees. The cost of run-off PI will be met by the acquiring company. This model is likely to qualify for Entrepreneur Relief, (subject to HMRC confirmation), which is payable at the outset with any adjustment being settled with HMRC in 15 years, or earlier if the exiting adviser decides to exercise an option to end the retirement plan at 5 or 10 years. If Capital Gains Tax after Entrepreneur Relief exceeds the initial 40% lump sum payment, this will be met by the acquiring company.
If you are thinking of selling your business, call us to discuss the options that are available in your area. A business is worth what someone is prepared to pay for it. Pre-planning is critical to a good outcome and representation through a reputable broker such as IFA Acquisitions Ltd will help you achieve a fair price for your business whilst meeting your needs and those of your clients.